Think Tank:

Tuesday, November 10, 2009

Different cultures have different days that are important to them. The Europeans don’t care about our Columbus Day, nor does the typical American even pause to think about Canadian Boxing Day. That’s easily understandable, as different world groups have unique reasons to remember special days.

But what about us? Collectively, we might be called the “Loosely Affiliated Group of Natural Gas Market Participants, Florida Chapter.” What holiday should we remember? Easy. We should care about Veterans Day. It is the number one holiday on our calendar.

On this holiday, it is important to remember the many folks that have protected our country through the years, sacrificing so much. But Veterans Day also roughly coincides with the last weekly natural gas storage build of the annual inventory season. Each week of the year, on Thursday, the EIA reports inventory builds and draws in the natural gas market. And, since the typical demand profile for natural gas is winter heavy and summer light, inventories build through the summer. If we were to look at a seasonal price chart of the natural gas market, we would find a rough correlation to the storage season – low prices in the summer as inventories build followed by higher prices during the winter as the market experiences periods of peak demand. (There are things that from year-to-year can disturb this seasonal pattern – hurricanes or economic “meltdowns”, for example – but the seasonal is still generally representative of the overall balance of gas supply and gas demand in the market.)

On this Veterans Day, the natural gas market finds itself at a bit of a crossroads. For months, the broad news media has been reporting on the development of unconventional supply sources – “shale plays” – in a broad swath of the midcontinent from Texas and Arkansas through to Pennsylvania and New York. New technologies have unlocked vast amounts of previously unavailable natural gas, causing a supply glut this year and drastically affecting the future supply-demand balance. Proven domestic reserves of natural gas have increased by 50% in the last two years.

These changes to the market have impacted price dramatically, pushing the price of cash natural gas in Louisiana to below $2.00/dekatherm in early September. But at that time, the curve of forward prices reflected a huge carry to the winter-time, typical of an over-supplied market. So although price was dirt cheap in the spot market, gas really couldn’t be bought in the forward market at a similar low price. But things change. Markets change. And now here we are….Veterans Day.

Since that point in September, the market has moved around a bunch. It rallied by almost $3.00, only to set back again under the pressure of mild weather and lack of early season heating demand. Now January gas is trading for $4.86/dekatherm on the NYMEX – on its face this looks to be around $3 dollars higher than that September low. But it is not. Because at the time that cash gas was below $2.00, the January NYMEX was trading for $5.00-5.25. So right now, the January market is at parity with its previous 2009 low.

Where it goes from here I guess no one knows. I have been watching, trading, and studying commodity markets for 15 years, and “no one knows” is one of the only things I know for certain. But let’s think briefly about the range of possible outcomes that the market could present to us. In the face of remarkably bearish fundamentals, the market remains around $5.00. Consider that until now the market has been presented with mild weather and building storages (remember Veterans Day?). But with the onset of more robust cold fronts and growing degree day counts, the market has the potential to rally. As I wrote in my last commentary, the two previous times this decade that the front month hit $2.75, within 12 months the market traded at above $9.00. The market will do whatever it has to in order to fool the majority.
Locking in a piece of fixed price at this level, one risks the chance that the market will fall to the sub-$3 level. But not locking in at this level is the equivalent to a bet that price WILL go down as we proceed into the winter supply drawing season. With Veteran’s Day upon us and the storage draws beginning, I don’t like the odds on that bet.

Tuesday, October 20, 2009

Experts now believe that the country has far more natural gas at its disposal than anyone thought three or four years ago. The revised estimates are largely due to advanced drilling techniques that make it economically feasible to extract the fuel from shale. And while the Marcellus is the most recently discovered and possibly the largest shale-gas deposit, others are scattered throughout the country. The U.S. consumes about 23 trillion cubic feet (TCF) of natural gas a year, according to the Department of Energy's Energy Information Agency (EIA). The Potential Gas Committee (PGC), an organization headquartered at the Colorado School of Mines, put the country's potential natural-gas resources at 1,836 TCF in a biennial assessment released in June. That's 39 percent higher than its estimate of two years earlier. Add to that the 238 TCF that the EIA has calculated in "proved reserves" (the gas that can be produced given existing economic conditions) and the PGC pegs the future supply at 2,074 TCF. In other words, there is enough natural gas to supply the country for 90 years at current consumption rates. Even if we used natural gas to totally replace coal in generating electricity, domestic supplies would last for 50 years.

Monday, September 21, 2009

"I used to say the nation is awash in natural gas," Hefner says. "Now I say we're drowning in it."

One area getting new attention is the Marcellus basin, a 400-million-year-old shale formation stretching from New York to West Virginia. That basin alone is believed to hold as much as 500 trillion cubic feet of natural gas, the equivalent of about 80 billion barrels of oil. (There are also large shale gas basins in Texas, Wyoming, Arkansas and Michigan.) It is not clear how much of the shale gas is recoverable, but the new production techniques have boosted all previous estimates.

Shale formations are deep underground — 6,000 feet or more — and the rock is relatively impermeable. Deep drilling is expensive, and in the past the amount of gas that could be reached was not considered sufficient to justify the cost.

Sunday, September 20, 2009

Mostly, I try to post only market info on this site. But I can't resist. This op-ed is by a conservative economist that teaches at Harvard.

I am confident that you will find it thought provoking. Below is an excerpt, the whole article is HERE.

Imagine that someone invented a pill even better than the one I take. Let’s call it the Dorian Gray pill, after the Oscar Wilde character. Every day that you take the Dorian Gray, you will not die, get sick, or even age. Absolutely guaranteed. The catch? A year’s supply costs $150,000.

Anyone who is able to afford this new treatment can live forever. Certainly, Bill Gates can afford it. Most likely, thousands of upper-income Americans would gladly shell out $150,000 a year for immortality.

Most Americans, however, would not be so lucky. Because the price of these new pills well exceeds average income, it would be impossible to provide them for everyone, even if all the economy’s resources were devoted to producing Dorian Gray tablets.

So here is the hard question: How should we, as a society, decide who gets the benefits of this medical breakthrough? Are we going to be health care egalitarians and try to prohibit Bill Gates from using his wealth to outlive Joe Sixpack? Or are we going to learn to live (and die) with vast differences in health outcomes? Is there a middle way?

Thursday, September 17, 2009

Since the last time I wrote an extended piece on this blog site, the market has moved significantly (56% higher than the low placed about 10 days ago). The market didn’t see this rally coming. And, searching for answers, analysts attempt to attribute a particular fundamental to what has transpired over the last 10 days. I don't think what has gone on is "fundamental" - as in supply and demand - at all. In my opinion, it is a dead-cat bounce.

This rally was a one of human emotion. It was caused by a blend of greed (or complacency) and fear. As the market fell, the front month price fell more significantly than the out months. This Rigzone article discusses that the steepness of the term structure contango was a four standard deviation event - meaning that the difference between the front month price and the out-month price is about as significant as it ever gets. Considering this, many shorts entered the market in the front month, knowing that the roll from month to month would credit their position and the term-structure "contango" would work in their favor. These speculative positions in the market were short in the face of the lowest gas prices in a decade. But they were making money, so they remained short. And then….the market rallied 15 cents. Some of them – the recent entrants – were then holding losing (unprofitable) positions. Trading with a stop-loss discipline, they said “enough is enough” and blew out – they BOUGHT. This pushed the market higher, and took even more trader's positions into negative equity situations. As nervous or disciplined investors, THEY headed for the exits, too. They BOUGHT. And this forced the market higher still. At this point the market had rallied maybe 50 cents. At this point, the market move started to attract the hot money that looks for trends with velocity. This money wants to jump on the trending market’s bandwagon and ride that bandwagon for a significant and quick profit. So…the move higher created by nervous investors exiting shorts is exacerbated by new “hot money” longs. The market has ingested these new positions by adjusting price, and by now it is more than a dollar higher. And...here we stand. Such is the status of the natural gas market on September 16th.

Old trader types say “if you drop it far enough, even a dead cat will bounce.” It is because the steady move lower allows folks to get out of position – to blend greed and complacency and find them in an unmanageable position should the market stop behaving in such a convenient and predictable trend. I perceive the recent strength as a dead-cat bounce and I look for more downside as the market adjusts from the exuberance of the last 10 days.

Let’s not forget: Natural gas storages are full. Rig counts are down, and gas production numbers still relatively flat to prior years. There are new and significant sources of shale bed supply that are shell-shocking the market to a new reality, and the demand base is slow to evolve to these breakthroughs. These are all short-to-intermediate term bearish considerations.

As I wrote in my last market commentary extended post, the last two times that natural gas prices have been this cheap, things turned around quickly. People that actively manage energy price risk should consider buying a piece of product at historically low prices if it fits their needs. And while we all get nervous in this situation, after the market rallies 56% off the lows, it seems reasonable to wait for prices to adjust after such a dead-cat bounce.

Wednesday, September 16, 2009

“The West, especially the Anglo-Saxon economies, went on a drunken binge of excess consumption, leveraged up the eyeballs with totally inadequate savings,” Roach said. “It was reckless, irresponsible and it’s over,” he added.

Tuesday, September 15, 2009

That is what Steven Schork says...here. (This article, from the Financial Times, is ABSOLUTELY worth the jump.)

"We stand by our words and our numbers. No doubt, gas is cheap. But, if there is no value, than cheap, in and of itself, is not a reason to own something. Back in the 1980s the Yugo GV was cheap also. The car was cheap for a reason. Its Soviet-bloc engineering (see today’s G.M.) exuded the feeling it was assembled at gunpoint1. Gas today is cheap for a reason.

There is too damn much of it. Over the weekend Alan Lammey at Natural Gas Week noted that ANR Storage was reported as 97.4% full, Sonat Storage was 97.3% full. Meanwhile, Texas Gas Storage was 96% full, Transco Storage was 83.3% full and Tennessee was estimated at 89% full… and it is only the middle of September for crying out loud."

Wednesday, September 9, 2009

"...[will] the demand for assets, such as stocks and bonds, will fall after the retirement of the baby-boomer generation—the segment of the nation’s population born between 1946 and 1964, whose oldest members turned 62 in 2008. Some economists have warned of the possibility of a dramatic decline in demand as baby boomers sell off their assets to finance their retirement; they assert that the sell-off could cause a dramatic decline in prices. An evaluation of the evidence, however, indicates that such a dramatic decline in asset demand and prices is unlikely."

Note how the use of the term “skeptics” suggests that Peak Oil is the mainstream view, which it is not. The word also links unbelievers to beyond-the-pale climate change “skeptics.” Finally, the report suggests that these people are suggesting a “golden age of exploration and supply” although in fact the only relevant quote is from Peter Odell, professor emeritus of international energy studies at Erasmus University in Rotterdam, who merely says, “It’s an amazing turnaround from the gloom of the last 10 years. All these finds will take a long time to bring on stream, but it shows the industry is capable of finding more oil than it uses and shows we have not come to any peak.”
Peak Oil theory represents a combination of economic ignorance and moral rejection of markets as greed-driven and shortsighted. These all-too common attitudes usually go with a profound faith in effective government policy, despite the monumental weight of evidence to the contrary.

The seminal image for depletionists -as for apocalyptic climate change theorists — is that of the photo of the Earth taken from Apollo 17; seemingly dramatic confirmation of finite resources on a “small planet.” In fact, the interpretation of the Apollo picture is symptomatic of how far technology has outstripped our primitive assumptions about the way the world works. But then people don’t have to think about the vast, natural “extended order” of the economy any more than they have to worry about how their spleens work. (italics are mine)

Debate between economists and Peak Oilsters tends to be a dialogue of the deaf. Economists often seem to imagine that they are explaining a technical issue. They note that the alleged failure to “replace” production is in fact due to the way reserves are reported. They stress that startling new technologies –such as the ability to drill in thousands of metres of water to depths of more than 10,000 metres (as at Tiber), or 3-D computer seismic imaging, or horizontal drilling –are constantly finding new oil and gas, and producing more from old reservoirs.

Again, citing how often alarms over “the end of oil” have been sounded since 1880 holds no sway with Peaksters. Since they see oil supply as essentially “fixed” and economists as deluded and morally deficient, delays in the projected “crunch” will only make it all the more painful when it –inevitably –comes."

Sunday, September 6, 2009

Barry Eichengreen, a professor at Cal-Berkeley, writes an essay in The National Interest about the future of economics after the fallout from the last year's crisis:

"...Work in economics, including the abstract model building in which theorists engage, will be guided more powerfully by this real-world observation. It is about time.

Should this reassure us that we can avoid another crisis? Alas, there is no such certainty. The only way of being certain that one will not fall down the stairs is to not get out of bed. But at least economists, having observed the history of accidents, will no longer recommend removing the handrail."

Tuesday, September 1, 2009

Monday, August 31, 2009

There is a famous Pentagon briefing that has been lampooned quite a bit. During this briefing Donald Rumsfeld steps to the podium to discuss the intelligence situation in Afganistan. He says:

"There are known knowns. These are things we know that we know. There are known unkowns. That is to say, there are things we know we don't know. But, there are also unknown unknowns. These are things we don't know we don't know."

He got a chuckle from some reporters. He got stares of confusion from others. As for me, I knew exactly what he was saying. And immediately I could relate it to my life. "Unknown Unknowns" in Secretary Rumsfeld's lingo, are things that we need to be worried about that we don't even know TO be worried about. .

When driving down the road, you know to stay on the right side as you crest a hill. There could be a car coming the other way. (Since you knew to be cautious, that is an example of a known unknown.) But as you crest that same hill and fall into a sinkhole created by recent rainstorms, you experience an unknown unknown (you didn't even realize that you needed to be worried about such a problem). .

As individuals that are affected by the energy markets, we are all impacted by known and unknown unknown variables. We are surrounded by known unknowns like hurricanes in the gulf or weekly storage inventory changes. And these make the market move. These variables have pushed the price of natural gas to 7-year lows. There are also unknown unknowns, like when the subprime mortgage snowball gained such inertia that a massive commodity deleveraging sell off took place (4Q 2009). The market did not even know to expect that one...it came out of nowhere, just like the sinkhole our car drove into in the previous paragraph. Unknown unknowns push the market much more violently and much more significantly when they appear. And no one can predict when they will arise and become important - that is the true nature and danger of an unknown unknown. .

By this point, no doubt, my readers think I am as crazy as the reporters found Donnie Rumsfeld that day at the poduim. But one of my favorite quotes from Charles Dow will help tie this together.

"There is always a disposition in people's minds to think that existing conditions will be permanent. When the market is down and dull, it is hard to make people believe this is the prelude to a period of activity and advance. When prices are up and the country is prosperous, it is always said that while preceding booms have not lasted, there are circumstances connected with this one which [are] unlike its predecessors and give assurance of permanency. The one fact pertaining to all conditions is that they will change."

The market will change. It will fall into the pothole of some great unknown unknown in a similar fashion to how the great commodity bubble of 2008 was popped by the economic crisis. It will change all of a sudden, in a shocking fashion, and in a direction that very few anticipated. Consider this fact:.

In the last 10 years, natural gas has been this cheap twice. Each time, within a year, the market traded near $10. The first time was in 1q of 2000 when gasd was trading just above $2.00. by December of 2000, when it traded for $9.73.The second time was in July of 2002, when gas was trading around $2.75. By February of 2003, gas traded for $9.33.
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Allow me some license to blend the statements of Secretary Rumsfeld and Mr. Dow:

"The known unknown pertaining to all market conditions is that they will change."